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Canadian Commercial Real Estate is a Compelling Play

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What are cap rates and bond yields telling us about real estate?

Despite some uncertainty regarding several commercial real estate asset types in a post-pandemic environment, investors continue to search for yield and commercial real estate remains highly appealing, especially in today’s low interest rate environment.  As a result, we continue to see many players with significant capital sitting on the sidelines and searching for opportunities.

  • Yield-seeking investors have a unique opportunity in real assets today.
  • The spread (premium) between the Canadian national average cap rate for the major asset classes to the BBB bond yield is at an historically wide 241 basis points (bps), up from 182 bps in 2019.  This is not as dramatic as the current 380 bps spread in the U.S.
  • Similarly, the spread between cap rates and the Bank of Canada 10-Year bond yield is at 465 bps, up from 375 bps in 2019.  This is comparative to the 475 bps spread between the United Kingdom all property average cap rate and the U.K. 10-Year Gilt.
  • This spread between the Canadian national average cap rate and the BBB yield previously peaked at 225 bps in both 2014 and 2012, and 222 bps in 2010, whereas the spread between cap rates and the Bank of Canada 10-Year bond yield peaked at 480 bps in 2008.
  • In a yield-starved environment, real estate makes for a compelling play.

Forecasts are calling for bond yields, and by extension commercial mortgage rates, to rise in the coming years, limiting the opportunity for continued cap rate compression, however, they likely will not rise as fast as the BBB yield or bond yields are projected to do.

Cap Rate Bond Yields Pic 1

Needless to say, there is significant variability by both city and more importantly property types.  Suburban office (at 594 bps), retail (at 508 bps) and downtown office (at 498 bps) offer the widest spreads.  Industrial (at 474 bps) and multifamily (at 331 bps), considered to be the lowest risk commercial real estate property types currently, offer spreads either close to or below the four-property national average spread.

Colliers will be releasing a Global Investor Survey next week, which will touch on sentiment domestically and abroad. Most investors are gearing up to deploy capital early in the year, and there are compelling reasons to put that debt and equity capital to work.